Can Your Retirement Plan Handle Rising Rates?

Now that the Federal Reserve has raised interest rates a quarter of a percentage point, you may be wondering: What does this mean for my retirement account? In the short term, as both, stock and bond markets react to the increase, even a diversified retirement account may lose value, but that’s no reason to sell your investments in a panic.

While a Fed rate increase can sometimes drive down stock prices and push down bond prices, if you can stay focused on your long-term goals, you can ride out these dips. Still, now is a good time to make sure your retirement savings plan is on track. In the context of rising rates, that means checking on the bonds portion of your portfolio.

Here are four tips to ensure your retirement account can handle rising rates.

1. Remember why you have bonds

Even if your investments have lost some value, remember that you’ve got bonds in your portfolio to provide returns. Your bonds act as a balance against stock market volatility. Bonds may fall, but not typically as far or as often as stocks. These two usually (though not always) move in opposite directions: When stock prices are rising, bond prices tend to fall, and vice versa.

Before you think about exiting bonds because you expect rates to keep rising, note that it’s as difficult to predict how fast rates will rise as it is to predict the next market crash.

Instead of trying to time the bond market, focus on what you can control. One step is to make sure your investment holdings are diversified. It can take as few as three to five mutual funds to make a well-diversified retirement account.

2. Realize that higher rates aren’t all bad news

Generally, bond prices drop when interest rates rise because existing bonds’ coupon — the interest they promise to pay while you hold the bond — is lower than the coupons offered by bonds issued under the new, higher rates.

Say you buy a $1,000 bond that promises to pay 1% a year. Then, interest rates rise. As a result, new $1,000 bonds promise a 2% payout per year. If you want to sell your bond, you’ll need to sell it for less than its face value to be able to compete against the new higher-paying bonds.

If you hold the bond until maturity, you’ll get paid its coupon rate and recover your principal when the bond matures, assuming the issuer doesn’t default. However, in retirement accounts, it is more common to invest in bond mutual funds, rather than individual bonds. In bond funds, the manager is likely buying and selling bonds on the secondary market. That’s where price fluctuations matter — and how your bonds can lose value.

While you might hear market prognosticators talking about the danger of holding bonds when rates are marching higher, they’re generally speaking to the problem faced by investors who only want to sell their bonds.

Long-term investors have less to worry about. While higher interest rates do mean short-term price drops, they also mean that your bonds mutual fund over time will buy higher-rate bonds, bringing higher interest payments back to you.

3. Check your bond holdings

Some bonds are riskier than others. In a rising-rate environment, bonds with long maturities are likely to drop the most in price. If you have a high proportion of long-term bonds, say terms of 10 years or longer, it might be worth shifting out of those.

The name of your bond fund should indicate average maturity, but if it doesn’t, read the fund’s description. Most investors tend to avoid bonds with maturities over 10 years.

The good news? Most workplace retirement plans don’t use funds with a duration over seven years.

4. Check your fees

Now that you’re thinking about your 401(k), it’s a great time to look at the fees you’re paying on all of your mutual funds. Your 401(k) plan may charge other fees, but making sure you’re in low-cost mutual funds is a great way to build retirement success.

Log in to your retirement account provider’s website and check each investment. Look for the expense ratio — that’s an annual fee expressed as a percentage of your investment — and make sure it’s less than about 0.50%.

If you can’t find any low-cost funds in your 401(k), then invest enough in the plan to get your company match and consider opening a traditional IRA or Roth IRA so you can invest in as many low-cost mutual funds as you may want.

If you need help planning for retirement and other services, such as medicare, just call us at 724-929-2300! Our agents will be happy to help you with any insurance needs to put retirement in reach.

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